George Stigler: Information is Power

It is July 4th weekend coming up. Woo hoo! Some of you will be traveling and doing some mini vacations somewhere. I don’t know about my plans for the 4th just yet, but I know that I am going to try and head out somewhere. As long as I escape the nation’s capital on the nation’s birthday, I’m game. One of the largest costs for any getaway is lodging, and hotels are really darn expensive! I also have to have a budget for my beer, my bathing suit, and some sunscreen since I will roast in the sun. Of course, I can’t leave without stopping by the local barbershop for a fresh cut. All of this is adding up to a lot of costs for a simple summer trip. So there has to be an alternative right?

Lucky for me, home sharing platforms like Airbnb and Homeaway are available, where I can rent out an entire home or apartment for a fraction of the cost of a hotel. Not only that, but I get a home experience as opposed to the hotel life. I’m only needing a pad to get some z’s anyway.

These home sharing platforms have been under fire lately, though. They are facing stiff regulations already in major markets like New York, Santa Monica, and New Orleans. In Washington D.C., a new battle is brewing over how to regulate home sharing. But, why? What’s more is why do we have regulations at all?

George Stigler, a masterful economist took a stab at answering that question and his insights have left a lasting impact on how we view this question to this day.

Businesses have so many different things that they have to take into consideration! Photo take from Sageworks.

The Winner

George Stigler won the Nobel prize in economics in 1982 for “for his seminal studies of industrial structures, functioning of markets and causes and effects of public regulation.”

Initially, he looked at monopolies in the movie industry by looking at block booking of movies. Block booking is where a studio would sell a bundle of films to a theater but the theater could not pick and choose among the movies in the package. Theaters would be forced to take on films that were probably not all that good along with the hits, supposedly paying higher prices. This led the Supreme Court to intervene and end this practice on the grounds that the movie companies were compounding a monopoly by using the popularity of the winning movies to compel exhibitors to purchase the losers. Stigler thought otherwise.

So, he wrote a paper displaying how a theatre would not be forced into a situation where they were paying a higher price. Theaters would not purchase these bundles unless they thought the best movie would bring in enough profit to account for the shitty movies that were in the bundle.

Another topic that Stigler popularized was “information economics” and how it pertains to monopolies and cartels. To Stigler, “information” has a critical role in how markets work. He theorized on how information, or the lack thereof, can create problems for firms that are trying to collude (or compete) when pricing out their goods and services. They do not know whether their competitors are secretly undercutting them. However, that uncertainty could be reduced by spending resources to gather more information. By applying some of these theoretical insights, he could show that collusion is virtually impossible the more firms are in a market. His preliminary dive into information economics paved the way for future Nobel laureates to make some substantial contributions in this arena.

Littlefinger has been able to navigate his way through the political climate of HBO’s Game Of Thrones because of his ability to acquire information.

Stigler Was A Stickler

He wrote a lot about the role of the regulator and the origins of regulations. He believed that regulations were brought on, not by the government, but by the industries themselves. Stigler called this “capture theory”. Capture theory was a fear that the producers in an industry would “capture” the regulating agency, using regulation as a tool to keep their competitors out. This theory and skepticism of regulators put Stigler at odds with the mainstream economists of his time.

Stigler argued that economists needed to study the effects of regulation rather than assume them. He criticized the great economists of the past who had spoken out for and against government regulation without ever trying to study its effects. In trying to promote this kind of discussion, he held a talk with Paul Samuelson to discuss the role of the state in the economic life of the nation.

Economist George Stigler, photo taken from the University of Chicago.

When Stigler challenged economists, they rose to the challenge. Economists, using powerful tools of empirical analysis, have found that government regulation of industries harms consumers, often giving monopoly power to producers.

To illustrate, let’s look at the barbershop I want to hit before going on my vacation. Barbers are partially regulated by mandating them to get a license. The story of occupational licensing has two sides, though. On one side, it can be argued that the purpose of the license is to be able to signal who is qualified to cut my hair. Another argument could be easily made that it is a method to restrict competition, forcing people to spend an inordinate amount of time and money to get permission to enter a field. Think about how crazy this sounds: In Florida, you need 1200 hours of training and 230 bucks to get a barber license. In the same state, it only takes 250 hours of training and 100 bucks to become an emergency medical technician. This is a case scenario where you can see how regulation by licensing can end up actually hurting people.

In a day and age where search costs are low and reputation effects are a huge factor in how people consume goods, licensing does very little to “protect the consumer” or signal quality. Using occupational licensing in fields such as locksmiths, hair braiding, and animal control officers, is rather unnecessary. Illinois, by the way, requires each of these occupations to have a license.

Perhaps the biggest impact was that he forced people both in the profession of economics as well as in the public service arena to think about the costs and benefits of regulation. On top of that, he was a great communicator that wrote and spoke in such a way that was down to earth. He was a model economist, capable of explaining his ideas in a way that could be understood by all.

The Economics of the “Return Trip Effect”

Have you ever walked to a particular location, say a friend’s house, and found that the walk actually was a lot farther than you had expected making it quite the unpleasant walk? But, you found that on the way back the walk seemed to go by much more quickly? There’s a scientific name term for this. It’s called the “return trip effect” (RTE). Continue reading “The Economics of the “Return Trip Effect””

James Tobin: A Cryptic Speculation

In the last six months, the price of Ethereum has increased by forty-five times from $8 a piece to a whopping $365. Should we be investing in a market that has these kinds of gains?

Ethereum is the latest instance of what is known as cryptocurrency. Cryptocurrency is a digital currency that is encrypted to regulate the amount of currency in circulation. A more well known one is Bitcoin. However, one of the reservations for investing in such a currency is that it’s extremely volatile; and it’s a reasonable fear, indeed. Ethereum’s price has fluctuated 40 dollars in the past week, with a 40 dollar dip in price followed by a 10 dollar recovery. That’s terrifying for people considering buying in.

One of the major causes for this type of fluctuation is that there is speculation in the market. Yes, speculation is that buzz word you usually hear watching the talking heads of the stock market, but it does have a meaning. It means investment in stocks or currencies with the hope to gain from fluctuating prices.

Although many see speculation as potentially dangerous, it’s an unavoidable part of the market. People are going to buy things when they see them as potentially valuable in the future. From Bitcoins to baseball cards, everything can be bought with the intent of selling for a profit when the value goes up in the future.

A potential problem arises when speculation outweighs transactions. That is to say, people are buying bitcoin for it’s speculated future value rather than using it to buy stuff from a retailer. Speculation on it’s own can create a lot of volatility in the market, as seen with Ethereum (now worth $327, a $40 drop since I started this blog post).

James Tobin saw this happening with foreign currencies, and wanted to find a way to slow the waxing and waning of their value down by curbing speculation. James Tobin was the winner of the Nobel Prize in Economics in 1981 “for his analysis of financial markets and their relationships to expenditure decisions.”

Nobel Winning Economist James Tobin. Picture taken from Wikipedia.

Tobin was regarded by many to be the most distinguished Keynesian, serving as one of John F. Kennedy’s Council of Economic Advisors. His realm of expertise was financial markets, and among his contributions two really stood out: Tobin’s q and the Tobin tax.

Tobin’s q is a mathematical method to analyze whether one should invest in a certain asset. Basically what the math determines is whether the asset’s value is greater than its replacement cost. For example, if the value of a house is greater than what it is being sold at in the housing market, then you should invest.

The more political contribution by Tobin is the Tobin tax. This was Tobin’s idea to reduce speculation in the currency market. Obviously, Tobin had no idea we would be dealing with cryptocurrencies, but he did want to curb foreign speculation in currencies. He saw the value of different currencies fluctuating wildly because people would “buy and sell” the money in order to make a profit. If investors with deep pockets, or if a bunch of investors with medium sized pockets decide to buy a bunch of Japanese yen, the value of the yen would increase. Conversely, if the investors that own a bunch of Japanese yen decide to sell it back, the value of the yen goes down. Doing this quickly and irregularly causes these unexpected fluctuations that make it tough for other investors to see the true value of the currency and making it harder to invest.

What he proposed was a tax that would be used on international financial transactions. This would hopefully reduce the amount of speculation occurring in the market since the costs of doing so would rise. However, as with all economics, there are many unintended consequences for these actions.

It’s important to note there’s very little empirical evidence that Tobin’s tax actually works. Even if it does, it reduces the liquidity of currencies and creates issues in other parts of the economy. Volatility of the market is unavoidable, and while scary, it’s a risk people have to take.

Tobin was a brilliant Keynesian economist, who was trying to address some legitimate issues with the financial markets. However, he couldn’t foresee the ineffectiveness, or even worse, the negative impact of his policy suggestions like the Tobin tax on foreign currency market.

When considering cryptocurrency, a tax wouldn’t work at all since one of the major benefits of currencies like Bitcoin and Ethereum is that they can’t be touched or regulated by the government. Cryptocurrencies will continue to be a high risk, high reward market until speculation in the market is outweighed by the amount of transactions occurring. As of right now, there are no meaningful policies we can implement to change that.

Cryptocurrency is a uniquely risky investment compared against your typical stock. However, you should treat these cryptocurrencies like an investment: Being cautious with when and how much you invest, and you would still be better off than if you simply left your cash in the bank for that same period of time.

The vast complexity of the world of cryptocurrency. Photo taken from Money Crashers.

Using Innovism Instead of Capitalism

McCloskey’s suggestion for changing the term “capitalism” into “innovism” might be a more practical way of arguing for free markets. Capitalism, as it’s tossed around in conversation, ends up getting misconstrued by both sides of the argument, because it lends itself to assume that societies have only become rich through the accumulation of capital. However, this is simply not true. It is ideas and the ability for entrepreneurs to assume the risks of employing the factors of production, by means of prices set in a market, to produce new (and perceived better) products or services to then turn around and sell them at uncertain prices in the market. The z, not the k, in our Solow model, if you will. This is “trade-tested betterment” as also proposed by McCloskey. Continue reading “Using Innovism Instead of Capitalism”

Fat Kids Unite: Seattle’s Soda Tax

To curb the rise of fat kids and raise some extra cash, cities across the country are attempting to tax sugar, particularly sodas. However, the potential health benefits might not outweigh the cost to consumers and businesses, especially in poor areas. Continue reading “Fat Kids Unite: Seattle’s Soda Tax”